1. The US Government will begin to engage in nominal GDP targeting financed by the Fed purchasing Treasury bills, notes, and bonds. Therefore, the Fed’s balance sheet will be higher than today.
  2. Decentralised finance (DeFi) will aggressively disintermediate many rent-seeking activities performed by centralised financial services institutions. The savings due to cheaper fees and more inclusiveness will flow to the end user and those who hold the tokens.
  3. The hyper growth of point 1 provides the push to accelerate point 2.
  1. In order to pay for WW2, the US government borrowed money. In order to keep its cost of funds down, the Fed bought bonds in a large enough quantity to fix the price of money. The long end was fixed at no greater than 2.5%.
  2. As a result, the Fed’s balance sheet rose 11x from 1939 to 1946.
  3. At its peak, the US debt to GDP ratio reached 110%; in order to inflate away the debt incurred to win the war, the Fed continued fixing the price of the treasury curve until the Monetary Accord of 1951, when the Fed regained its independence from the Treasury.
  4. Unfortunately, the plebs were forbidden to privately own gold, so they suffered severe negative interest rates and high inflation. They had nowhere to go but government bonds and equities.
  5. By 1951, the US government successfully delivered its balance sheet, dropping the debt / GDP ratio from 110% to 70%. Now the Fed could allow the free market to operate once more in the US treasury market.
  1. In 2020, the war on COVID caused US GDP to drop the most since WW2.
  2. In response, the USG, run by the Republicans, spent the most money in aggregate terms in US history.
  3. The Fed, while not engaging explicit price fixing of the treasury curve, bought 55% of all treasuries issued in 2020. This resulted in their balance sheet growing 76% in 2020.
  4. US debt to GDP reached an all-time high of 130% by the end of 2020.
  5. The Democrats were elected, and just like the Republicans, swiftly enacted a few trillion-dollar spending bills and promised to do much, much more.
  6. The US is now a dual deficit country; it spends more than it receives in taxes (fiscal deficit), and it imports more than it exports (negative capital account).
  7. US politicians in both parties are vocal that the government must aggressively expand fiscal spending to right the wrongs of the past, and ensure labour is protected in the aftermath of COVID.
  8. Foreigners are not waiting around to watch their $7 trillion worth of US treasuries get decimated, and on a net basis only bought 8% of treasuries issued in 2020 vs. 42% of all treasuries issued from 2002 to 2019.
  9. The only politically acceptable option is aggressive fiscal spending paid for by Fed money printing.
  10. Thankfully, in 2021 we have the crypto capital markets, which are not a target for some government agency or central bank.
  11. While the tens of trillions of dollars created by the Fed will not all flow into crypto, some of it will — and because crypto is unencumbered it can rise to a level that allows holders to maintain purchasing power in the face of monetary inflation.

War = Inflation

War is a terrible thing. It’s even worse when you, as a taxpayer, have to pay for it directly. That is why governments would rather resort to the stealth tax of inflation than aggressively raise taxes to pay for war. The population might turn out to be a bit too pacifist, leading to a chorus of objections regarding the use of their tax dollars.

  1. To participate in a war is expensive, and governments would rather tax indirectly via inflation than directly via taxes on wages and capital.
  2. The central bank’s independence is a chimera. When domestic agendas require central banks to print money to cheapen borrowing costs of their government, the central bank will always follow orders.
  3. In order to de-lever the government’s balance sheet, the government must be able to borrow cheaper than the nominal GDP growth the expansion of debt creates.
  4. The release valve is the balance sheet of the central bank, because it must rise as high as needed in order to absorb the amount of government debt the public refuses to purchase at the government’s artificially depressed interest rate on offer.
  5. This monetary inflation will manifest itself in financial assets and real goods.

The COVID-19 Forever War

According to official statistics, approx. 600,000 Americans have died in the past two years with a cause of death attributed to COVID-19. Approx. 400,000 Americans died during WW2. All human lives are precious, but to a domestically elected politician those who die within your squiggly line domain are the most important.

  1. The Fed has not set an explicit target for government bond yields. It appears they prefer an orderly, non-volatile rise in yields to some level that we don’t know yet. Because they haven’t set a target, they can say with a straight face they are not engaged in Yield Curve Control (YCC). That is important because, remember what Governor Eccles said earlier — if the Fed is doing YCC their balance sheet will expand to whatever level is necessary to keep yields at or below their target. As the balance sheet expands, so does the money supply, and that creates the environment for inflation.
  2. The Fed’s liabilities are not legal tender. In English, the Fed doesn’t just print money and spend it directly from their account. Instead, they engage in a little game of ring around the primary dealer desk. The Treasury has a treasury auction, the primary dealers bid on bonds, and the Fed immediately buys the bonds from the dealers at a small markup. Everybody wins. The USG gets their wampum, the banks get paid to take zero risk, and the Fed gets to claim they are not directly financing the government.
  3. 2020 was a blow-out year. Crypto went to the moon and is currently reeling under the awesome effects of Earth’s gravitational pull. Are we done yet? Will the Fed’s balance sheet continue to rise, taking all types of financial assets with it? Let’s peer into Pepe’s crystal ball.
  1. The USG needs to continue spending aggressively.
  2. The Fed needs to buy the majority of the bonds issued so that interest rates remain at affordable levels for the USG.

Risks of a Declining Fed Balance Sheet

Foreign Bag Holders

Source: The World Bank

How High?

The point of this essay is to argue that, in order to fight the war with COVID and avoid exacerbating social unrest, the only politically acceptable course of action is nominal GDP targeting paid for with borrowed money. In order to keep the cost of borrowing lower than achieved growth, the Fed will expand its balance sheet to whatever level is necessary.



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Arthur Hayes

Arthur Hayes


Co-Founder of 100x. Trading and crypto enthusiast. Focused on helping spread financial literacy and educate investors.